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Economic Consequences of Populist Demands

In an interview with a media house, Arvind Panagriya, said that a poll promise is a ‘fair game’ if it is a one-time sop and does ‘not create long term liability’ for the next government, the 15th Finance Commission Chairman,NK Singh termed it freebies as a ‘quick passport to financial disaster’ on similar grounds the world has witnessed the chaos that unfolded in Britain after it failed to implement a combination of populist expenditure proposals that led to the ejection of Lizz Truss as the PM. Populist measures like protectionism against immigrants and free trade were also featured in the policy positions of the Trump administration in the US. Populist promises and demands mostly include income redistribution,public spending increases,rise in trade barriers and tariffs,tax cuts,restrictions on immigration and a pro-nationalist or anti-global rhetoric.
Before state/general elections in India,political parties often make such promises to attract vote share, making them an indispensable part of Indian elections.

It is very unlikely for any citizen to vote against temporary fiscal policy expansion measures such as the tax cuts that boost consumption and investment,these measures by the government have the capacity to spur growth in the short term,however, they have the potential to hinder growth, fuel inflation and result in a loss of competitiveness and productivity over the long term,ultimately leading to constrained fiscal space and higher debt burden.Economists argue that an economic hardship-in particular trade protectionism measures such as trade shocks and immigration crises lead to rising economic inequality and changes in opportunities in the labour market that leads to financial distress and anxiety in certain segments of society.

A populist demand irrespective of it being left or right does not have a single definition, but is characterized by its claim to represent the “will of the people” against the “enemies of the people”- minorities and foreigners (in the case of right-wing populists) or financial elites (in the case of left-wing populists),such populist demands lead to the distribution of freebies veiled as welfare programmes as they serve as an easy way to sway voters and conceal failures

This article aims to highlight the longer term economic consequences of such demands, which claim to protect the interest of common citizens against the elites.

A section of the society might decide to vote against the incumbent government if it believes that another party is in line with their economic interest in the present,which often motivates parties to make large claims without any financial backing thus the government in line with its populist claims abandons fiscal responsibility,funds the public demands through excessive government borrowing,causing economic calamity every time,thus a bias for the present by the voters can offer gains in the short term but is termed bad economics in the longer term.

The Supreme Court of India in 2013 questioned the veracity of freebies because they impacted the notion of free and fair elections as not every party had access to the public funds which disturbs the level playing field of elections.
It is difficult for a citizen to gauge the impact of such discretionary policies due to time inconsistency,an example can be of an expansionary monetary policy where the government in power can increase the money supply in the market,which leads to a rise in prices and an increase in output in the short run,firms and households adjust their expectations,which in the long run only leads to higher inflation without any output growth and employment gains.Such time inconsistency problems undermine the pursuit of policies desirable in the longer term.This intrinsic riskiness makes populist politicians particularly attractive to disappointed voters, who have already lost a lot relative to their expectations and therefore attach a large value to the chance of getting back towards their reference point.
The states need to remember the consequences of spending more than they are earning and not lose sight of growing fiscal stresses on them.Freebies,price distortion through cross subsidies,eroding private investment incentives and subsidy burden have taken a heavy toll on already stretched state finances. The share of the states in the tax revenue has dropped,and the cesses imposed on them by the Centre have been raised,continuation of such practices will deteriorate the conditions of states which have been exacerbated by Covid-19.

Gargi Yadav
Research Assistant,
Center of Policy Research and Governance.